Insolvencies have spiked – would a law change let more businesses trade their way out of trouble?

New Zealand has been experiencing a striking rise in company failures, focusing attention on the role of directors when facing financial trouble.

Corporate insolvencies have now reached their highest levels in 15 years, with thousands of firms entering liquidation or other formal processes in 2025.

This surge has coincided with a new Law Commission review of directors’ duties – the first comprehensive assessment since the Companies Act was passed three decades ago.

The review, due to report in 2027, will examine the core duties imposed on directors, their liability for breaches and the wider set of laws that place personal obligations on them.

At a time when a concerningly large number of companies are collapsing, two key provisions in the act should take on particular significance to the review: sections 135 and 136.

Together, they set the rules for how directors must act when a company is nearing insolvency.

When protection becomes constraint

Insolvency basically means a business can’t pay debts when they’re due, or that total debt is more than the value of all its assets. When a company is close to this point, directors may be tempted to “gamble for resurrection”.

By that stage, shareholder equity is often exhausted, meaning further risk-taking is effectively funded by creditors’ money. It is here where the two provisions, known as the insolvent trading duties, are designed to tackle the same problem in different ways.

Section 135 of the Companies Act effectively blocks directors from allowing a company to trade in a way that creates a substantial risk of serious loss to creditors. Section 136 requires directors to ensure the company can meet new obligations when they fall due.

In effect, they both stop downside risk from being shifted onto suppliers, employees and Inland Revenue once insolvency looms.

But the law is not without flaws.

Section 135 has long been criticised for its vague, open-textured language. Expressions such as “substantial risk” and “serious loss”, for instance, offer little practical guidance to directors when making business decisions.

Unlike judges, directors must make decisions in real time, often under severe financial pressure, yet their actions are judged later in court.

In such strained circumstances, the section’s lack of clarity risks pushing directors toward overly cautious decisions – or deterring them from taking risks that could help the company recover.

Another concern is that the section may even discourage sensible risk-taking in some situations.

This issue was highlighted in the Supreme Court’s 2020 decision on the high-profile case of Debut Homes Ltd v Cooper. The court noted how directors could breach the section by continuing to trade, even where it was a sensible business decision and could improve returns for some creditors.

This makes the current rules difficult to justify. If liability depends mainly on the presence of risk rather than likely outcomes, directors may favour immediate liquidation over strategies that could improve returns for creditors.

In the long run, this could lead to viable firms being liquidated too early and economic value being lost.

How NZ’s laws differ

Other jurisdictions take a more flexible approach.

In Australia, the law focuses on directors incurring new debts while insolvent rather than prohibiting continued trading altogether.

A statutory “safe harbour” also protects directors who pursue a restructuring plan reasonably likely to produce a better outcome than immediate administration or liquidation, provided certain conditions are met.

In the United Kingdom, directors become liable only once they knew or ought to have known there was no reasonable prospect of avoiding insolvent liquidation. From that point, they must take every step to minimise losses to creditors.

The United States is more permissive still. There is no general statutory duty requiring directors to cease trading upon insolvency, and courts apply a strong business judgement rule that protects directors acting in good faith, on an informed basis and without conflicts of interest.

In New Zealand, the argument for reform is not about weakening creditor protection, but that the current law may discourage legitimate rescue attempts in borderline cases. Concerns about legal risk may also deter capable individuals from accepting board roles.

The Law Commission’s review of directors’ duties offers a timely opportunity to reconsider the balance the law strikes between creditor protection and sensible risk-taking.

New Zealand could consider repealing section 135 and relying on other provisions to address irresponsible conduct. It could also introduce a statutory safe harbour modelled on Australia’s approach.

Alternatively, it could make clear that liability should arise only where creditors as a whole are likely to be worse off than under immediate liquidation, based on the information reasonably available at the time.

Whatever the review finds, it is clear the current law deserves a closer look.